Internal audit reporting lines,fraud risk decomposition,and assessments of fraud risk

The main purpose of this research is to examine the effects of internal audit reporting lines on fraud risk assessments made by internal auditors when the level of fraud risk varies. Significant emphasis has been placed on the importance of reporting lines in maintaining the autonomy of internal auditors, but the perceived benefits of requiring internal audit to report directly to the audit committee have not been validated or systematically investigated. Results of an experiment involving 172 experienced internal auditors and additional survey findings indicate that internal auditors perceive more personal threats when they report high levels of risk directly to the audit committee, relative to management. Perceived threats lead internal auditors to reduce assessed levels of fraud risk when reporting to the audit committee relative to when reporting to management. This finding runs counter to the anticipated benefits of requirements that the internal audit function report directly to the audit committee, and it reveals potential conflicts of interest and independence threats created by the audit committee itself. We also investigate the effects of fraud risk decomposition on risk assessments made by internal auditors. We find that fraud risk assessment decomposition does not have the same effects on internal auditors as it has on external auditors, and the effects of decomposition do not align with the expected benefits of decomposition.     

The influence of auditor narcissism and moral disengagement on risk assessments of a narcissistic client CFO

Global capital markets rely heavily on independent and skeptical auditors as gatekeepers to provide assurance that corporate financial reports are free of material fraud. The rise of narcissism among the ranks of both client and audit professionals challenge this gatekeeper function. In addition, auditor moral disengagement may undermine auditor skepticism, further eroding public confidence in the integrity of financial reporting and the audit process. We conduct a quasi-experiment with 118 auditors from three international audit firms. In a simulated interview with a client CFO, we examine whether auditors underestimate risks of fraudulent financial statements due to the interactive effects of (1) client narcissism (manipulated verbally and nonverbally) and (2) auditor narcissism. We also examine the influence of auditor moral disengagement on client risk assessments. Results indicate that CFO verbal and nonverbal narcissism significantly influenced auditors’ assessment of management-related client risk. Moreover, auditor narcissism was found to interactively influence client risk inferences such that auditors higher in narcissism exhibited narcissistic tolerance (lower risk assessments) when the hypothetical CFO displayed high verbal narcissism. Auditor moral disengagement was negatively associated with client risk assessments. We discuss the implication of these findings on future audit judgment research, audit firm policy and training on maintaining auditor skepticism, and the audit oversight role of standard-setters.     

Integrating business risk into auditor judgment about the risk of material misstatement: The influence of a strategic-systems-audit approach

Auditing standards direct auditors to consider business risk and other risk factors when they evaluate the overall risk of material misstatement during the planning phase of an audit. Large audit firms generally use either a strategic-systems approach (SSA) or a transaction-focused approach (TFA) to evaluate misstatement risk. This study used data from a laboratory experiment to examine whether (1) being trained to use either SSA or TFA and (2) analyzing information organized in an SSA or TFA format influence the extent to which auditors integrate knowledge of business risk into their judgment about the likelihood of financial misstatement. Only auditors trained to use SSA who analyzed information provided in an SSA format effectively integrated business risk assessments with their assessment of the risk of material misstatement.     

Triangulation of audit evidence in fraud risk assessments

Drawing on the triangulation framework of audit evidence ( and ), we experimentally test for the conditions, if any, under which financial-statement auditors alter their fraud-risk assessments based on whether external evidence provides positive or negative news about underlying business performance. We focus on the condition in which two kinds of management-controlled audit evidence – evidence from the financial statements and evidence from internal data depicting performance of a key business process – is contradicted by external evidence suggesting that a key business objective has not been attained. According to the triangulation framework, such contradictory external evidence should heighten auditors’ skepticism about the veracity of management-controlled evidence and increase their assessment of fraud risk.     

Preparers’ control‐risk assessments under alternative audit‐review processes

This study investigates the impact of a decomposed audit‐review process on audit preparers’ control‐risk assessments, taking audit experience into consideration. Using an experiment, it manipulates the audit‐review type (decomposed review versus non‐decomposed review) and preparers’ audit experience level (more experienced versus less experienced). Analysis of data collected from two mid‐tier audit firms supported the author’s predictions. First, working‐paper preparers assessed control risk more accurately in a decomposed than in a non‐decomposed review. Second, less‐experienced auditors benefitted more from a decomposed review than more‐experienced auditors.     

Classification techniques for the identification of falsified financial statements: a comparative analysis

In this study, I develop 10 alternative classification models using logit analysis, discriminant analysis, support vector machines, artificial neural networks, probabilistic neural networks, nearest neighbours, UTADIS and MHDIS for the detection of falsified financial statements. The models are developed using financial and nonfinancial data. The sample includes 398 financial statements, half of which were assigned a qualified audit opinion. I compare these alternatives methods using out‐of‐time and out‐of‐sample tests. The results are used to derive conclusions on the performance of the methods and to investigate the potential of developing models that will assist auditors in identifying fraudulent financial statements. Copyright © 2009 John Wiley & Sons, Ltd.     

The (mis)fit between the profile of internal auditors and internal audit activities

This study investigates whether there is a fit between the profile of internal auditors and the activities of the internal audit department (IAD). It also seeks to discover which type of internal auditors fit which type of internal audit (IA) activities. This is commonly referred to as the person-job (P-J) fit. Furthermore, this study investigates whether this (mis)fit is associated with the outsourcing/co-sourcing of IA activities and turnover within the IAD. Bringing strategic human resource management (SHRM) into IA can be considered as the key contribution of this paper. The results of this study are based on a questionnaire completed by 280 members of the Institute of Internal Auditors in Belgium. The results show that there is a fit between some characteristics of internal auditors working in an IAD and the activities of the IAD. The results also show that certain internal auditor characteristics fit with certain types of IA activities. However, the degree of fit varies. Furthermore, it was found that IADs that co-source/outsource were significantly more associated with a misfit between the profile of the internal auditors and the activities of the IAD, whereas a misfit was not significantly associated with a high turnover of internal auditors.     

The effects of experience and explicit fraud risk assessment in detecting fraud with analytical procedures

This paper reports the results of an experiment that examined the effects of audit experience and explicit fraud risk assessment instructions on the effectiveness of analytical procedures in detecting financial statement fraud. The results of this study suggest that audit managers are more effective than audit seniors in assessing the risk of fraud with analytical procedures. Additionally, explicit fraud risk assessment instructions resulted in more effective assessments of the presence of fraud. These results have implications for the assignment of auditors to tasks and the structuring of these tasks.     

The influence of litigation risk and internal audit source on reliance decisions

External auditor reliance on the work of internal auditors in an integrated audit of the financial statements and internal control is an important audit planning procedure that can impact audit efficiency and effectiveness. The purpose of this study is to examine how perceived auditor litigation risk and internal audit source affect external auditors' reliance decisions in an integrated audit environment under varying levels of risk of material misstatement. In an experimental study using 89 practicing Big 4 auditors, this study finds that auditors who perceive low litigation risk from placing reliance on the work of internal auditors will rely more on outsourced internal auditors than in-house internal auditors. The results also show that auditors' reliance decisions are sensitive to the level of account risk consistent with the risk-based approach to the integrated audit encouraged by the PCAOB.     

Analysts' Cash Flow Forecasts,Audit Effort,and Audit Opinions on Internal Control

We examine the economic impact of analysts’ cash flow forecasts by looking at how external auditors respond to financial analysts’ issuance of cash flow forecasts. Using a differences‐in‐differences approach, we find that financial analysts’ initiation of cash flow forecasts leads to reduced auditor fees and audit report lags. Moreover, after cash flow forecast initiation, firms report fewer Section 404(b) internal control weakness disclosures. These findings suggest that cash flow forecasts constrain earnings manipulation and improve management accounting behavior, thereby reducing inherent and control risk and strengthening firms’ internal control over financial reporting.     

Internal control audits: Judges' perceptions of the credibility of the financial reporting process and likely auditor liability

This paper reports the results of a study in which fifty-seven sitting United States judges participated in a behavioral experiment to assess the perceived credibility of the financial reporting process and the legal risk auditors bear under conditions where they provide an internal control audit report (vs. no report) under two corporate governance environments. We find that participating judges believe internal control audits provide enhanced assurance that intentional misstatements do not exist and also serve to provide elevated protection to the public, but only under conditions of a strong corporate governance environment beyond current regulatory requirements. We also find that, after being informed of an undetected material fraud, judges who currently have high expectations of the auditing profession find auditors more liable when an internal control audit report has been issued (as compared to when no such report has been issued).     

Auditors’ going‐concern‐modified opinions after 2001: measuring reporting accuracy

An important change in auditors’ reporting behaviour in the period after the high‐profile corporate collapses in 2001 is that auditors were more likely to issue going‐concern (GC)‐modified audit opinions. Comparing company failure rates subsequent to receiving a first‐time going‐concern (FTGC)‐modified audit opinion in the pre‐ and post‐2001 periods, we find a consistent type 1 error (misclassification) rate (the rate of survival among companies issued an FTGC opinion). Results are indicative of auditors maintaining GC reporting accuracy when comparing the 1995–1996 and 2004–2005 periods. This conclusion is supported after considering the impact of mitigating circumstances surrounding companies that received an FTGC‐modified audit report and survived.     

Corporate social responsibility and the assessment by auditors of the risk of material misstatement

This paper investigates whether, and how, firms’ corporate social responsibility (CSR) performance influences the auditor's assessment of the risk of material misstatement, whether due to fraud or error, at the financial statement level by analysing their pricing decision (i.e., audit fees). Using a panel data set of 12,330 firms from 28 countries over the period 2003–2012 and different measures of CSR performance, we find a U‐shaped relationship between firms’ CSR performance and audit fees. This result suggests that there is an optimal level of CSR performance that minimizes the auditor's assessment of the risk of material misstatement, which in turn lowers the need for greater auditor effort; that is why auditors charge firms significantly less when their CSR performance is at the optimal level. Finally, we also show that the optimal level of CSR performance varies with the degree of environmental dynamism, ownership concentration and leverage.     

Are non‐audit services associated with firm value? Evidence from financial information system‐related services

The purchase of non‐audit services from incumbent auditors has generated considerable attention. Surprisingly, limited empirical evidence exists on the association of non‐audit services with firm value. Focusing on services related to financial information system (FIS), we find that the market value of equity is greater for firms that purchase FIS‐related services from their incumbent auditors relative to firms that do not. The levels of FIS fees are also positively related to firm value after controlling for total other fees, or total other non‐audit fees. Hence, despite the negative perception associated with non‐audit services, investors regard FIS‐related services as value‐adding activities.     

THE IMPACT OF THE FINANCIAL REPORTING REVIEW PANEL ON ASPECTS OF THE INDEPENDENCE OF AUDITORS AND THEIR ATTITUDES TO COMPLIANCE IN THE UK

The UK Financial Reporting Review Panel (FRRP) enforces the regulatory framework for larger companies and requires companies to restate non-compliant accounts. It is authorized to deal with directors but not auditors. Recent UK based research indicates a belief that the FRRP's activities have enhanced auditor independence and changed attitudes to accounting compliance. Defective accounts indicate a lack of audit quality as the auditor must have failed to detect and/or prevent the deficiency. By analysis of fifteen semi-structured interviews with finance directors and audit firm partners with experience of an FRRP inquiry, and by review of publicly available information, the impact of the FRRP on some aspects of audit quality is sought. The FRRP is found to have motivated auditors to improve accounting compliance by increasing the possibility of some errors being exposed. It is also found to have enhanced the independence of auditors at the pre-conventional level of ethical cognition as identified by Ponemon and Gabhart (1990), by changing the cost-benefit for auditors of permitting non-compliance. FRRP inquiries cause auditors to incur non-recoverable costs, can undermine the auditor–client relationship and increase the risk of client loss. Personal embarrassment, possible career damage and the risk of an ICAEW disciplinary inquiry arise for the audit partner. The FRRP is found to provide auditors with an additional negotiating tool in dealing with directors, thus making in easier for auditors at the conventional and post conventional level of ethical cognition to prevent non-compliance. Direct evidence is, therefore, found that the FRRP's activities have provided incentives for all auditors to focus more on accounting compliance (at least for items visible from an inspection of the accounts) and have provided incentives and mechanisms for auditors at lower levels of ethical cognition to be independent.     

University Audit Departments in the United States

Internal auditors of public and private universities were asked about their selection processes, supervisors, and activities. At public institutions, the governing board selects the internal auditor, the president supervises the work and more audit findings are implemented. Private institutions have more audit committees that are involved with the internal auditors' activities and their auditors perform more program audits. Thus, although public universities are following professional guidelines more closely, suggesting more accountability, private universities have greater access to audit committees and perform more value-added audits.     

The effects of tone at the top and coordination with external auditors on internal auditors’ fraud risk assessments

Prior research suggests that internal auditors’ judgements are subject to management influence resulting in compromised risk assessments. This study investigates the effects of the tone at the top and coordination with external auditors on internal auditors’ fraud risk assessments. Results of an experiment involving 64 internal auditors indicate that when the tone at the top is poor, rather than favouring management, internal auditors report a higher risk of intentional misstatements and that coordination with external auditors can further reduce expectations of the incidence of intentional misstatements.     

审计师收取客户债务风险溢价了吗?

已有研究发现,公司债务风险越高,审计师收取的审计费用越高;然而,审计费用提高的原因可能是审计投入的增加,也可能是审计师收取客户公司的债务风险溢价。由于缺少审计投入的数据,已有研究无法回答审计师是否收取客户公司债务风险溢价的问题。本文以我国A股上市公司为研究样本,运用我国独到的审计工时数据,就此展开相关问题研究。研究发现,在控制了审计投入之后,客户债务风险与审计费用显著正相关,表明审计师收取了客户公司的债务风险溢价。进一步研究表明,审计师对财务状况较差和治理较差的公司以及非国有企业收取更高的债务风险溢价,规模较小的会计师事务所收取的债务风险溢价高于规模较大的会计师事务所。     

International evidence on economic policy uncertainty and asymmetric adjustment of audit pricing: Big 4 versus non‐big 4 auditors

By investigating the association between economic policy uncertainty and audit fees using data from eight countries, this study examines whether and how Big 4 auditors reinforce their advantages over non‐Big 4 auditors through audit pricing. We find that both Big 4 and non‐Big 4 auditors reduce their audit fees when economic policy uncertainty increases. However, while non‐Big 4 auditors adjust audit pricing asymmetrically as economic policy uncertainty changes, i.e., the magnitude of decline in audit fees when economic policy uncertainty increases exceeds the magnitude of rise when economic policy uncertainty decreases, Big 4 auditors regulate their audit pricing in a symmetric manner. Further analyses reveal that: (1) the asymmetric pricing of non‐Big 4 auditors mainly exists in countries where Big 4 auditors have dominant market share, (2) Big 4 auditors provide higher‐quality audits when economic policy uncertainty increases and (3) many firms in better financial condition turn to Big 4 auditors during uncertain years. Our findings suggest that the symmetric audit pricing helps Big 4 auditors maintain a favorable position in the audit market.